The board of directors of the Los Angeles Police Protective League weighed in on a bill passed by Congress – HR 4348 – signed by the President on July 6th.
As far as bills go, it is not in the league of the Affordable Health Care Act, but its passage was important to the White House as part of the administration’s plan to provide jobs through infrastructure improvement projects. It took bi-partisan support to craft it; President Obama praised Senator Boxer and Representative Mica for their leadership.
The LAPPL chose to twist one of the bill’s provisions into a reason to defend its fanciful position regarding the earnings rate assumption used for projecting the growth of the Police and Fire Pension System’s assets. The earnings rate assumption is a critical component in determining the plan’s unfunded liability.
The higher the rate assumption, the lower the unfunded liability and, all other things being equal, the lower the contribution the city has to make to support pension benefits. The bill allows private defined benefit plans to use a computation that raises their rate assumption. I will tell you why the seemingly unrelated provision is in the bill a little later.
There has been much controversy over the earnings rates used by public pension funds because of the significant effect they can have on a state’s or city’s financial position.
The public unions prefer a high rate in order to disguise and understate the potential financial risk state and local governments face – that is, the residents, stakeholders and taxpayers who are liable for the shortfalls in funding guaranteed benefits to the participants. Union leaders would rather hide the truth from the people than get them riled at the prospects for a financial meltdown capable of taking down a city. That would not sit well in a city like Los Angeles where all of the elected officials depend on support from public employee unions to fuel their campaigns. These same officials also negotiate compensation and benefit packages for the employees.
In its blogpost, the LAPPL referred to a New York Times article that claimed the new method of calculation – allowing firms to use a 25-year interest rate average instead of the low rates that have prevailed for several years – would produce an earnings rate of 7%. The LAPPL strongly implied hypocrisy was at work. After all, key supporters of the new calculation generally have been the same ones pressing for legislation to require public employee unions to lower their estimates.
There are a couple of very important facts the critics failed to disclose in their post………. deliberately, I’m sure.
Let me say that I do not like the concept of using a 25-year average. In the world economy of today, twenty-five years ago is the equivalent of prehistoric times; ten years ago is ancient history. The key players and the amount of influence they wield have changed dramatically. There is little to compare between the present and over a decade ago, yet too many people have a soft spot for historical data. It is easier to get your hands around the past than project the future, an uncertain one at that.
Despite my reservations with the historically based calculation, the end result estimated to be 7% is still measurably lower than the 7.75% rate currently in use by the city’s sworn and civilian pension systems. Three-fourths of a point may not sound like much, but it could increase the unfunded liability for Los Angeles by at least $500 million, an amount that would have to come from the general fund. That’s not good news when services have already been slashed due to layoffs.
The Los Angeles Civilian Employee Retirement System (LACERS) only recently cut its assumption from 8% to 7.75%. At that, the decrease will be phased in over five years, deferring the inevitable pain of higher employer (that’s us) contributions to later years. The only strategy City Hall knows when it comes to managing deficits is deferral.
It is highly likely that HR 4348’s new rate assumption calculation will drop below 7% as older higher interest periods drop from the calculation and are replaced by the ultra-low rates of recent years. For example, the prime rate was in excess of 10% 25 years ago. It is 3.25% currently. Rates in general reflect this steep decline.
It would not surprise me to see it land at 6.5%, a level consistent with the view of Mayor Bloomberg of New York. If 6.5% were in effect for Los Angeles, the unfunded liability could easily grow by another $1 billion. Where do you think the City Council will find that amount of money in the years to come?
The LAPPL post went on to criticize proponents of using a low risk-free rate as the earnings assumption. I agree we do not have to go that low, but at least the theory of using a risk-free rate is more logical than the politically motivated rates cooked up by actuarial firms hired by public union boards.
When a plan offers a guaranteed benefit regardless of market performance, it should use conservative estimates to assure funding is also guaranteed. In a public plan, anything less than a conservative assumption exposes the taxpayers to bailing out the beneficiaries in the event of a market collapse or a prolonged downturn.
So why was this 25-year average provision included in HR 4348, a bill designed to fund highway improvements, not to mention preventing the doubling of student loan rates (yet another unrelated provision)?
The higher rate of return reduces corporate deductions, thereby increasing tax revenue. The bill also increases the premiums corporate plans pay into the Pension Benefit Guarantee Corporation, the insurance fund designed to lessen taxpayer exposure to private sector pension failures. Wouldn’t it be nice if public employee plans paid a premium into a comparable program?
These changes will provide in excess of $18 billion in funding to the highway projects over the next ten years, enough to balance revenue with costs.
It was a good deal for all concerned.
Was it the best deal?
Is there ever such a thing as a “best deal?”
Public union members are rightfully concerned about their pension benefits. However, union leaders are downright defensive if anyone should challenge their tenuous assumptions. They will react as Dracula does at the sight of a crucifix.
These leaders will always remind their members of state constitutional protection of public pension and benefit contracts.
But contracts can be worthless if one of the parties cannot perform. If taxpayers do not want to cover deficits created by underfunded plans, bankruptcy will result and a judge will lower the benefits.
Union members should ask if the deal they have is too good to be true. Bernie Madoff promised high returns; his investors only wish they had asked that question.
The late Jim Valvano, whose NC State basketball team pulled off one of the greatest upsets in Final Four history, rode a surge of popularity after winning the national championship. Seven years later, he was forced to resign in the wake of recruiting violation allegations. The NCAA cleared him, but NC State wanted him out. He wrote an autobiography: They Gave Me a Lifetime Contract, and Then Declared Me Dead.
Union members should consider making major concessions in the form of higher employee contributions lest a bankruptcy judge declares their plans dead.
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